By John F. Di Leo
If you’re going to import or export goods (and surprisingly, even if you’re not), among the first things to learn is the Harmonized Tariff Schedule (HTS) classification of your products. This code is used for determining the duty you pay, as well as a host of other things, from quotas to Free Trade Agreement qualification, to the countless regulatory requirements managed by agencies other than Customs.
Import duties have been around for thousands of years, but of course they started out very simply. Over the course of time, countries decided to set different duty rates for clothing, food, beverages, furniture… then broke it down further with different rates for cotton or wool, for meat or vegetables… then further still, breaking down each of these into dozens of specific varieties based on content, quality, level of processing, and more.
By the 1970s, every country on earth had its own duty schedule, with tariff books three or four inches thick, with thousands of different codes for every possible product that could be imported or exported… every country’s book looking completely different. The regulators of the world decided that life would be much easier for everyone if they shared the same coding system for this process. It took them a while, but by the mid-1980s, the World Customs Organization (WCO) released their masterpiece, and the Harmonized classification system was born.
In this system, all the products on earth – all the physical goods that could possibly be traded – are divided into 99 chapters, starting with animals and plants, moving on to food products, moving further on to elements and minerals and chemicals, and finally moving on to completed machines, electronics, furniture and vehicles by the end of the book.
Every country doesn’t use the exact same number, but the system is harmonized, meaning that interpretations are supposed be done according to the same rules, and the first six digits of the code are supposed to be identical globally, allowing for each country to differ in the last few digits, based on how much detail they want to go into, and how many different duty rates they want to apply to the same general product group. One country might have a dozen different duty rates for steel screws but only one rate for steel nuts, for example, while another might reverse the difference; such country-specific choices are handled in the last few digits of the code.
Since we in the USA have set ten digits for our version of the HTS, we hope and expect that the first six digits of our code will be the same in every country we work with, and only our last four digits will be specific to the USA.
Why Do We Care?
The HTS system applies to every import and every export; that alone is a good reason for the small businessman to pay attention to it. But it’s about more than just straight duty rates. Here are just a few of the major reasons that the HTS code will affect our business, whether we export or import, or even if we are a totally domestic company, selling our product to only fellow American customers:
Here are a few of the major issues determined largely by a product’s HTS code:
- Duties: The basic duty rate the importing country applies to the shipment.
- Other taxes assessed on top of duties: Many countries assess a Value Added Tax – VAT – upon the value of goods+duty, so getting the classification wrong could mean causing your customer to get his VAT wrong.
- Import or export quotas: The USA has far fewer of these than we used to, but many countries still have lots of quota limitations.
- Export Controls: While most of the USA’s export control licensing regimes are based on the dual-use and munitions list systems, some of our export controls, such as those on Russia, do use the HTS… and many other countries use the HTS exclusively for export controls.
- Free Trade Agreement (FTA) certificates: The HTS code determines the qualification tests required to generate most FTA certificates. It’s not enough to have made a product here; to qualify for NAFTA or DR-CAFTA or most of our other FTAs, you have to look up the Rules of Origin for the product’s HTS code, and perform the specific tests required for it in the agreement, or your product cannot claim duty-free status (and yes, those rules are very different from FTA to FTA!).
- Other regulatory agency requirements: Customs is only one of many government agencies involved in importing and exporting. The FDA, USDA, EPA, FCC, F&W, and many other government agencies govern some import shipments, but they don’t all participate in the import process. Customs acts as the gatekeeper for all these agencies, and builds triggers into their systems so that they can tell from the HTS code whether another agency might need to authorize an importation.
- Anti-Dumping, Countervailing, and other punitive duties: In addition to the basic duty that applies to all imports, governments occasionally decide that one or more foreign governments are breaking the rules of international trade, such as by subsidizing exports below-cost in order to intentionally hurt our market. Such findings result in often-astronomical additional duties, such as the 10% and 25% punitive duties that were all over the news in 2018, or the even higher 50%, 100%, even 150% or more antidumping duties known as ADDs. These programs aren’t always directly tied to the HTS code, but Customs uses the HTS code to flag the entry so the case can be analyzed.
- Classification of other products: This may seem strange, but it makes sense: HTS classification doesn’t occur in a vacuum. Some products are specifically provided for in the book, while many are not. If you’re making a part for something else, for example, say, a door panel for a refrigerator or a base for a toy, the classification of your part may (or may not, depending) be partially determined by the classification of the master product for which it was made. (This issue – parts classification – is an entire subject on its own!).
If we think about it, it becomes clear that we need to know our products’ HTS codes even if we never intend to import or export them. We should know the duty rates on our foreign competitors’ products, for example, in order to better judge how to price our own domestic products to be competitive… we ourselves might never sell our product internationally, but our domestic customers will ask us whether our products qualify for NAFTA (or or many other FTAs) or not… and if our product is export-controlled, then that fact governs who we can use as vendors, carriers, customers, engineers, and potentially almost everything else about our product. Classification really isn’t just an import/export issue.
The Book is Online
Most countries publish their tariff codes online, and the USA is no different. The most current version of the USA HTS is always found on the United States International Trade Commission website, at hts.usitc.gov. While you can still obtain the books on printed paper, that’s a risky choice because the code is updated at least a couple of times every year; the online version is always kept current. Sometimes these changes involve thousands of classifications, and even though the odds may be against your particular products being involved, it is always possible.
To walk through the HTS code, we need to begin with a few definitions.
- The Parts of the HTS Code: As mentioned before, the book is organized into 99 chapters, and only the first six digits are universal. The segments each have their own legal status, and play a particularly important role not only in duty determination but also in FTA qualification.
- Chapter: the first two digits
- Heading: the first four digits
- Subheading: the first six digits.
- The full 10-digit number is simply called the HTS code or classification.
- Description: The description shown next to the classification is legally binding. Pay close attention to such things as whether words are separated by semicolons or commas, and whether they mention including parts or not. These kinds of issues govern Customs’ judgment when ruling on a challenging classification question.
- Units of quantity: The book may just show an X here, but if it asks for numbers, net weight, linear meters, etc, then they might just be looking for reporting stats, but this might also play a role in determination of duties or other fees, or even quota limits. Note also that Customs usually requires metric measurements, so you may need to do conversions if you buy or sell in English measures like pounds, feet, or gallons.
- Columns 1 and 2: In the USA, we have split our duty rates into two groups. The first is the Most Favored Nation (MFN) group, or Column 1. All but two countries on earth get the Column 1 rates. That leaves two countries – Cuba and North Korea – to get the astronomical Column 2 rates (this is a holdover from the Cold War; Column 2 used to include the USSR and the captive nations of Eastern Europe, but they were moved to Column 1 when the Iron Curtain fell in the early 1990s). Since we are banned from almost all commerce with Cuba and North Korea, you should never encounter Column 2 in your business.
- General and Special: Column 1 is itself split into two sub-columns, one marked General and the other marked Special. If the product was made in a country or country group listed in the Special column, and it was imported from there directly, and you have proof (generally in the form of a certificate from the vendor) that the product qualifies for the agreement… then the goods will get the duty rate listed there (usually zero)… but if all three requirements are not met, then the product reverts back to the duty rate shown in the General sub-column.
- Footnotes: Some classifications are followed by a foot note, which refers to an entry later in the book, in chapter 98 or 99. These are generally additional punitive duties – antidumping, countervailing, etc, sometimes country or vendor specific, but not always – and sometimes also include other provisions such as import quotas. If you product is covered by a footnote, check it right away… if applicable, these are usually enormous.
Now that we know, generally, what these columns mean, let’s look at a few common examples from the book.
Golf Clubs and Ping Pong Sets
Let’s look first at ping pong sets. We find these at 9506.40.0000. As you can see, the US doesn’t break them down at all; your paddles and ping pong balls are all classified with the same code, which carries a 5.1% import duty rate, assessed on the Transaction Value of the shipment (note that Column 2 says they’d be 30% from Cuba or North Korea, but you won’t be importing theirs!).
But now, we look to the right, and see that the Special column is chock full of entries. Turns out this product is provided for in many of our reciprocal and unilateral trade agreements, making it duty-free if the shipment qualifies. “A” is the GSP program, covering about 140 countries of origin… AU is the reciprocal free trade agreement between the USA and Australia… BH is the reciprocal free trade agreement between the USA and Bahrain… CA and MX mean Canada and Mexico, under the NAFTA agreement (which might soon be replaced by the new USMCA). There’s a list explaining all these codes at the beginning of the book, in the section entitled General Notes.
All in all, about three-quarters of the nations on earth participate in one or more of these programs. Just remember, the goods only get this duty-free treatment if they were imported directly from the named country (or through another member of the same agreement), and if your vendor can prove qualification if Customs audits you. Don’t take advantage of NAFTA or any other such program without a certificate from your supplier!
This was an easy one. Now let’s look above it to golf supplies. Here we see different duty rates for golf clubs (4.4%) vs. golf balls (free). You’ll note that there’s a list of potential trade agreement duty breaks in the special column for the golf clubs, but not for the golf balls. Why not? That’s because if the product is unconditionally free (carrying a zero duty rate), then there’s no point in worrying about the free trade agreements. They only list the possible FTA programs if the product would otherwise be dutiable.
It’s easy to get lost in the questions of “Why?” when reading through these pages. Why are golf balls free but not golf clubs? Why are cross country skis duty-free, but not alpine skis? Well, the reasons vary. It could be because, at some point long ago, one group of importers or manufacturers had an effective lobbyist, or because the government needed revenue one year and looked for things to tax that few would notice or complain about. There are a thousand reasons, and unless you’re in a position to lobby on the matter, it’s usually best not to worry about it. These rates are usually out of our hands; we just need to understand them and make sure we classify our goods correctly.
And this is critical: While some products are very clear in the HTS, many are not. Don’t assume that you can find the correct classification for your product on your own. If you do any importing and exporting, you should already have a Customs broker and freight forwarder who can assist in these matters; hiring outside consultants is sometimes wise.
Note: The Customs Modernization Act of 1993 clarified the requirement that businesses own the responsibility for getting all this right. The Mod Act established an obligation in the business community to take Reasonable Care to act in an environment of Informed Compliance, and stipulated that in most cases, businesses cannot just blame their broker/forwarders for errors. So yes, we should use broker/forwarders because they are the experts, but we must remember that they are not mind-readers; they are dependent on our giving them all the information they need to provide good advice. And in the end, it’s the business, not its outside consultants, who will be held responsible for getting this stuff wrong.
Resources
The HTS pages aren’t the only resource that you or your consultants will use to classify your products. Each chapter has guidance notes at the beginning, called Chapter Notes, and each group of chapters is likewise preceded by a set of Section Notes. There’s a set of General Rules of Interpretation at the beginning of the book that’s shared by almost every country on earth; part of the deal in getting countries to join the Harmonized approach was agreeing to go through the classification process the same way as everyone else. In addition, many countries, including the USA, publish their customer-specific Customs classification decisions, called Binding Rulings, which can give others a better understanding of how Customs interprets such things.
Free and easy primary resources, available online, are therefore:
- HTS classification pages
- Chapter Notes
- Section Notes
- General Rules of Interpretation
- Customs Ruling Online Search System
There are other resources for complex classification challenges, such as the Explanatory Notes, court decisions from the Court of International Trade, and rulings by foreign countries’ Customs ministries. These are difficult for the American layman to get at, but when needed, your broker/forwarder or other consultants can access them.
How are duties calculated and paid?
Once we know the product’s classification, we can figure out what our duty will be. Let’s consider the aforementioned table tennis set, with its 5.1% duty rate.
In most cases (there are exceptions), we pay duty in the USA based on the Transaction Value (the actual price paid or payable), not counting international transportation.
So let’s say you bought $10,000 worth of ping pong paddles and balls, on a delivered basis, and your vendor charged another $1000 for the international transportation piece. You can deduct that transportation amount when you have supporting documentation for it (such as a rated freightbill showing the actual international freight charges). We multiply the $10,000 times 5.1%, and our duty is a simple $510.00.
We aren’t done quite yet, however. We will have a small Merchandise Processing Fee (MPF) that Customs even charges on duty-free items… and if we imported through a US seaport, there’s also a tiny Harbor Maintenance Fee (MPF) to add. Together, these add just under another half percent to our Customs payment. In addition, as mentioned earlier, many other products are hit by punitive duty rates, such as Antidumping and Countervailing duties. These are cumulative, and your Customs broker’s computer system will catch the red flags to identify which ones may apply, as long as your value, classification, and country of origin are correct.
Before we leave this question, we must ask, how sure are we of that $10,000 number? “Well, that’s what’s on the invoice,” you say. But what if there’s something else going on behind the scenes, something not mentioned on the invoice? What if we paid the vendor a couple thousand up front, “to tool up for the job?” Or what if we send him a mold first and said “here, I want my imprint on the handles”… or if we sent him some parts and said “here, I want you to use these components in your assembly”… Almost anything you’ve sent to a foreign vendor, not just money, but anything, if it increases the value of the final product that you import, is usually going to have to be declared as part of the dutiable value of the import.
These valuation issues are the subject of another column, but just be aware for now: we must declare the actual price paid or payable, and if there were more payments that aren’t reflected on the invoice, then you will need to tell your broker about them, so he can add them in. We don’t want to underdeclare the value, because that would cause us to underpay the duty. And that would make Customs think you did it on purpose.
In Conclusion
The import-export world is fascinating, with millions of codes, complicated rules, and efforts by well-meaning bureaucrats to ensure that international trade is managed as fairly as possible. But it can be a huge challenge as well, and therefore can’t be taken too casually. This isn’t taught in school; most companies learn these lessons the hard way – through fines and penalties. That’s not the best way to learn anything!
The Customs broker filing documents on your behalf is limited by what the seller and buyer have told him. If the documents are incomplete, or if descriptions were misleading, he can’t help you; he’s not a mind-reader.
The job of the entrepreneur is therefore to think through all this and be proactive, sharing everything you can think of that might be relevant with your broker, so that he can give you the best advice, and help you protect yourself – and your customers! – from the risk of Customs thinking you did something wrong… or worse yet, thinking that you did something wrong on purpose.
Be careful out there!
Copyright 2019 John F. Di Leo
Originally Published in MoneyCrashers, January 2021
John F. Di Leo is a Chicagoland-based Customs broker and trade compliance trainer. He has been working in international trade, in various capacities on both the manufacturing and service sides of the desk, for forty years now.
Note: this is a short summary of a very extensive topic, and does not constitute legal or tax advice. Readers are encouraged to use this as one of many resources to learn about the subject and to utilize major international Customs brokerages and freight forwarders to ensure compliance and success.